Thursday, February 28, 2008 35 Comments

Return to Castle Goldenstein: the gold market in a nutshell

With the Fed sounding like they share an office with the Hillary campaign - any minute now, I fear, Dr. Bernanke is going to crack and accuse Greg Ip of fluffing the euro's pillow - and the metals markets bubbling over like a bad quesadilla, perhaps it's time for me to share some of my eccentric thoughts on the old yellow fellow.

Our goal today is to understand the gold market, from King Tut till now. We'll start with abstract economics, whip through some financial history, and wind up in the weird world of ETFs, DGCs, the CBGA, Comex and the IMF. If these letters mean nothing to you, all the better. Most of what most people know about gold is, in my humble opinion, wrong.

Of course, my opinions about gold are just that. I am neither an economist nor a financial professional. I am certainly not a registered investment advisor! Everything I know about precious metals, I taught myself. If any aspect of my presentation inspires any confidence or respect, I am probably doing something wrong.

At the very least, please do not make financial decisions with reference to my eccentric economic theories, which are probably also fascist, sexist and anti-Semitic, unless you are at least sure you understand them and could defend them in a fair argument with an intelligent and well-informed paperhead. I should also mention that my own derisory savings are all in cash, ie, gold and silver bullion - not, in case anyone plans a raid on Castle Moldenstein, retained therein. (Can you say "Zurich," boys and girls? I knew you could!)

First, the fundamental fact about gold is that it is a natural currency. James Turk (whose satisfied customer I am) is by no means infallible, but this brief post of his makes as good an introduction as any. This lovely freelance piece in the SF Chronicle, by local comedy man Rob Baedeker, is the first sympathetic treatment of a goldbug I have ever seen in any newspaper. When gold is hip, governments wake up in a stone-cold sweat.

However, the starting point for my amateur aurology is a mysterious essay that appeared in 2006 on the notorious doom-mongering financial aggregator Safehaven. Its author, the blatantly pseudonymous John Law, has not reappeared and does not appear to be answering his email. I think it's pretty safe to assume he was run over by a bus. While I certainly don't agree with all of Mr. Law's opinions (and it should be noted that the financial crisis he predicts, a currency run, is not at all the same thing as the financial crisis which is happening now, a bank run), I think his basic theory of money is more or less right. If gold is money, there's no way to explain gold without explaining money. So let me give it a whack.

To make a long story short, Law's theory of money is that currency selection is a coordination game, driven by appreciation effects rather than coincidence of wants. As we'll see, this is not quite the same as the Menger-Mises Austrian theory of money, but it could be seen as a variant - "neo-Austrian," perhaps. The classical Austrians had many advantages. Game theory was not among them. But if you think of Mises' "regression theorem" as a sort of proto-game theory avant la lettre, you may be on the right page.

Perhaps this is all gobbledegook to you. What is money? In our usual UR style, try and forget everything you know about the stuff. Imagine you are an incredibly advanced alien, and your spaceship has developed some kind of awful navigation defect that misrouted it to Planet Three. While you're waiting for the natives to advance their crude technology far enough to at least patch your quantum warp belt, you have nothing better to do than to study their barbaric economic habits, past and present.

You notice an weird pattern of trade that seems to hold across a variety of civilized societies. I'll let Carl Menger describe it, in his On the Origins of Money (1890):
There is a phenomenon which has from of old and in a peculiar degree attracted the attention of social philosophers and practical economists, the fact of certain commodities (these being in advanced civilizations coined pieces of gold and silver, together subsequently with documents representing those coins) becoming universally acceptable media of exchange. It is obvious even to the most ordinary intelligence, that a commodity should be given up by its owner in exchange for another more useful to him. But that every economic unit in a nation should be ready to exchange his goods for little metal disks apparently useless as such, or for documents representing the latter, is a procedure so opposed to the ordinary course of things, that we cannot well wonder if even a distinguished thinker like Savigny finds it downright 'mysterious.'
In other words, Menger - writing of course in the heyday of the classical gold standard - observes the following mystery: a strange good which appears to be of very little use at all, and yet is fervently desired by everyone.

First, note the contrast with modern goldbug twaddle of gold's "intrinsic value." While gold is certainly more useful than green slips of paper, the difference is minor in perspective. Pretty much anything you can get in exchange for a Krugerrand is much, much handier around the house than the Krugerrand. While it is not obvious that the same logic explains the anomalous valuation of Krugerrands and benjamins, Occam's razor suggests that we should at least give it a shot.

There is a second strange observation, which Menger doesn't make but I will. This is that, in addition to being anomalously overvalued, the good in question is anomalously stockpiled. For example, there are about 150,000 tons of gold in the world today, most of which is being used for nothing at all. Obviously the same observation holds for paper currencies.

This is a very different pattern than we see for other commodities in the Wall Street sense of the term - say, wheat, or zinc, or frozen concentrated orange juice. While there are warehouses full of all of the above, the stock-to-production ratio of gold is orders of magnitude higher than for any other good (even other precious metals). Since annual gold production is about 2500 tons, the gold industry keeps 60 years of inventory on hand. Imagine if this was the case for, say, iPods. Or even zinc. Its bizarre stock-to-flow ratio is the easiest way to see that, even in the futuristic techno-world of 2008, gold remains a monetary commodity.

(It is very difficult to distinguish "monetary" from "industrial" users of gold, largely because a large percentage of today's gold stockpile is held in South Asia as investment jewelry. The linked Daniel Gross essay, sourced from the egregious Virtual Metals, is a classic example of how analyzing a monetary good using ordinary commodity-market tools produces gross systematic errors. Except for psychological reasons, it matters very little how much gold is extracted every year. The number could go up to 5000 tons or down to 0. Either is a small addition to the stockpile. There is no reason to assume that these small annual deltas have any large direct effect on the gold-dollar exchange rate. Gold is gold, new or old.)

So, putting our alien hat back on, we have a rough general picture of this strange phenomenon, "money." It is a good that is either not very useful or downright useless, but still is considered very desirable, and is stockpiled in large quantities.

Why would this be? Is it some quirk of hominid psychology, an irrational, instinctive attraction which leads the violent hairy biped to crave shiny metals and pictures of dead presidents? Is this why every advanced society seems to have at least one such good?

We certainly can't rule it out. However, a simpler answer presents itself.

Suppose our hominids are engaging in the following pattern of trade, which we'll call the monetary transaction pattern. At time T0, our hominid produces some original good or service, O, and exchanges it for some intermediate good, I. He holds I until time T1, when he exchanges it for some final good or service, F, which he consumes.

Between T0 and T1, the subject thus holds a stockpile of I, a good which he has no plan to use. Does this ring a bell? Perhaps the phenomenon we call "money" is the result of a whole society of hominids who, for whatever bizarre bipedal reason, have all chosen the same I.

This explains the anomalous stockpile. It does not explain the anomalous valuation. And it tells us nothing about why hominids might engage in this odd behavior. Why, for example, doesn't our hominid just keep O until T1, and exchange it directly for F?

Here's a simple example of the MTP. Our subject, Sven, is a fisherman. His original good, O, is fish. Salmon, perhaps. His final good is a white Cadillac convertible, with wire wheels. His plan is to net salmon for 20 or 30 years, then buy the Caddy.

If Sven just keeps O until T1, he will have a huge pile of rotten salmon in his backyard. Frankly, this is no way to retire. Hope is not a retirement strategy, especially when all your assets are in fish. At least it's liquid - sort of. But it won't get you any Cadillacs.

So Sven exchanges O for a storable good, I, such as palladium, and he is happy. In other words, the MTP exists because the Svens of the world want to exchange present goods for future goods, O at T0 for F at T1, fish now for Cadillacs later, and because not all O are storable. Therefore, Sven has to select some good which is easy to store, I - palladium.

One way to understand the MTP is to create a strange world in which it does not exist. Imagine if we modify Nitropia so that anyone can trade with anyone, anywhere, by teleporting goods. In addition, we'll assume that all goods can be stored perfectly without any overhead. Is the result a premonetary equilibrium, in which no one has any reason to stockpile an item he has no plans to use? I believe it is, but it is also about as unrealistic as it gets. With all the monsters in the world, a Nitropia with these rules would be pretty boring.

We can break this premonetary equilibrium in a number of ways. And herein lies the rub.

Menger's classical Austrian theory of the origin of money relies on the coincidence of wants. (The same is true for the latest neoclassical theory, that of Kiyotaki and Wright, which may interest you if you're behind the firewall and have some kind of pathological, Aspergery obsession with mathematical pseudocode. Otherwise, stick with Menger, or his successor Mises, or later Rothbard. The classical Austrians may not have been right about everything, but at least they knew how to explain economics in English. Or German, anyway.)

In Menger's world, Sven selects palladium for a very simple reason. He has salmon and nothing else. At T0, he trades with someone who has palladium, and wants salmon. At T1, he trades with someone who has a Cadillac, and wants palladium.

Why palladium? Why do we use TCP/IP, rather than DecNET or Appletalk? Because it's the standard. Translating between standards is a pain in the butt. When standards compete, one tends to win and the others go away. Sayonara, HD-DVD. In Sven's world, money is palladium. Gold is an exotic industrial metal, sometimes used for plating speaker cables. There is no one who wants to trade gold for salmon or Cadillacs for gold.

The basic problem with Menger's approach, from my perspective, is that he's concerned with the historical origin of money, whereas I am concerned with its logical origin. What Menger wanted to know is how money actually happened. What I want to know is how it can happen.

So: clearly, in the actual historical context in which money originated, the coincidence of wants was a serious problem, and Mengerian effects would no doubt appear. On the other hand, in Nitropia, with its advanced teleportation technology, barter is a trivial problem. If Sven wants to use gold as his I, and he finds a salmon buyer who has nothing but palladium, no problem. He trades salmon for palladium and palladium for gold, and he is there.

Wall Street is not Nitropia. Financial engineering is nifty, but it can't teleport bullion. But Wall Street looks a lot more like Nitropia than either looks like, say, ancient Greece. If we are concerned with the gold market today - and why shouldn't we be? What is economics, touch football? - Nitropia is probably a better model.

And it is a fact that even in Nitropia, as long as there are fish which don't keep and fishermen who want to retire, the MTP makes sense. Which means any Nitropians who practice the MTP must select some intermediate good I. And since the coincidence of wants is not a problem in Nitropia, Menger's analysis cannot apply.

Thus we see that Menger did not find the origin of money. He found an origin of money. That is, he found one way of breaking the premonetary equilibrium - eliminating teleportation - which could trigger one process of monetary standardization. Menger's analysis does not and cannot show that the coincidence-of-wants effect is the only force that can result in standardized money. Perhaps there is another? Indeed there is.

Back to Sven. Suppose that Sven can select any intermediate good I he wants - for any I, the transaction cost of exchanging salmon for I, or I for a Cadillac, is comparable. He is not bound in any way by the monetary preferences of salmon-eaters or Cadillac-makers. His choice is truly his own - or so it seems. So how does he choose?

The question is a little open-ended. Let's narrow it down. Suppose Sven is choosing between only two possible intermediate goods - Ia or Ib. Say Ia is palladium, and Ib is rhodium. What is Sven's algorithm?

It's actually quite simple. All Sven cares about is the change in the exchange rate between palladium and rhodium, across the time window T1 - T0 of the transaction. If (Ia/Ib)@T1 is greater than (Ia/Ib)@T0, he prefers palladium. If it is smaller, he prefers rhodium. In other words, he will prefer the I which will appreciate more across his monetary time window.

Of course, this has to be adjusted for storage costs and financial returns. If there is a financial market denominated in rhodium, and rather than keeping his rhodium under the mattress Sven can lend it out for a secure 3% rhodium-on-rhodium return, this is part of appreciation. If palladium is radioactive and needs to be stored in an expensive lead-lined chamber, effectively consuming 2% of its weight every year, the same applies. But even with this 5% difference, if the palladium-rhodium exchange rate is rising at 10%, Sven goes with palladium.

But how does he know what the exchange rate will do? He doesn't.

(Even a futures market cannot solve Sven's problem for him. Futures markets are notoriously bad at predicting exchange-rate fluctuations, because loan markets simply transpose future price fluctuations into the present. The gold futures market, for example, cannot predict rises in the gold price higher than the cost of borrowing dollars: otherwise, arbitrageurs can borrow money, buy gold, sell it in future, and collect the differential between the predicted price rise and the dollar interest rate. In fact, this would be a beautiful way to suppress the gold price, if not for that "buy gold" step.)

All Sven can do is think. And this is where the game theory comes in.

If Sven is thinking rationally, which admittedly is a big if for anyone named "Sven," he will realize that he is not the only Sven in the world. Whatever intermediate good he chooses, someone else will choose it as well. If there's one Sven, there's a herd of Svens.

And since buying and selling any good cannot fail to affect its price - ie, its exchange rate against other goods - we have a feedback loop. The herd selects an intermediate good based on its predicted exchange rate. But the exchange rate cannot be predicted without knowing the herd's selection. Problem!

Imagine the market for palladium, before the entry of this herd. Since palladium is not being used as an intermediate good, everyone who owns palladium has some actual use for it. Suppose, for simplicity, that this use is destructive - perhaps palladium is eaten, like wheat.

It is very easy to describe the pricing of wheat. Wheat is correctly priced when the price is such that wheat demand equals wheat supply, and wheat stockpiles neither grow nor shrink. Perhaps you've seen Wall Street stories about commodities markets in which inventories are said to be rising or falling. Commodities traders use these reports to guess whether the price at present is too high or too low. If they're right, they profit, if they're wrong they lose.

But why should wheat stockpiles neither grow nor shrink? Because no one wants to stockpile wheat. In other words, because wheat is not a monetary good (for one thing, it doesn't keep). In fact, if wheat was not a seasonal crop, it would probably be produced under modern just-in-time supply chain discipline, with almost no stockpile at all. Since it is a seasonal crop, it has some optimal stockpile. But it's certainly not 60 years of production.

This is why the normal techniques of commodities valuation strike out when applied to monetary goods. They are relying on an assumption that just isn't true. If the size of the stockpile is not controlled, there is no point at which "supply equals demand." Jessica Cross and her ilk are trying to solve for one variable in a two-variable equation. They might as well be reading tea leaves.

A fellow named Shayne McGuire, whose main claim to fame is that he's not a traditional goldbug at all but actually a state pension fund manager, has just put out a new book with the charmingly blunt title Buy Gold Now. I haven't read it, but I skimmed it a little on Amazon and it looks pretty good. In this interview, he expresses the difficulty well:
Any MBA holder, who has been taught to value almost any asset, hits a stone wall when faced with gold: it pays no dividend or coupon, and without deriving a cash flow, the basis of most assets defined as being financial, there is no conventional way to determine its dollar value.
Indeed (except that I would say "there is no conventional way to predict the exchange rate between gold and dollars.") You cannot calculate it as if gold was a stream of future dollar payments, because it isn't. You cannot calculate it assuming that the gold stockpile needs to converge on a constant, because it doesn't.

But Sven - if his Ia and Ib are not platinum and rhodium, but gold and dollars - has to compute exactly this number. How in the heck does he do it? Or does he just close his eyes and guess? Let's go back and look at the feedback loop again.

First, we need to establish that Sven's problem is indeed (as I claimed earlier) a coordination game. In other words, Sven's goal is to pick the same intermediate good that everyone else picks. Why?

Because of herd effects. There are two cases to consider. In case A, Nitropia has not yet chosen a standardized currency. In case B, it already has.

First, case A. Nitropia is just emerging from the premonetary equilibrium. All goods in Nitropia, including both palladium and rhodium, are priced as industrial commodities - ie, they are demanded only by direct users. Suddenly, a software upgrade introduces fish, thus motivating the MTP, thus generating a herd of Svens.

Let's separate this herd into two strategies, by eye color. If Svens have blue eyes, they follow their proper MBA reflexes and diversify, buying equally priced lots of palladium and rhodium. But if they have brown eyes, they buy only rhodium.

Who does better? The brown-eyed Svens. Why? Because the MTP has created new demand for both palladium and rhodium. There was no monetary demand before we broke the equilibrium - now there is. Ceteris paribus, the price must go up.

But we've created more demand for rhodium than for palladium. Thus, ceteris paribus, rhodium will appreciate against palladium. And thus the brown-eyed, undiversified Svens will wind up with more pimped-out Caddies.

In fact, it is even uglier than this. Because if we then relax the eye-color constraint, a substantial percentage of blue-eyed Svens are liable to say the hell with it, and ditch their palladium. To buy rhodium. Thus shoving the palladium-rhodium ratio even deeper into the dumps. There is only one end to this game.

Nor is this the worst. The worst is that, before the palladium-rhodium wars end, with the victory of the rhodium bugs and the obliteration of the palladiumheads, palladium had its little moment in the sun. Its price, too, rose above the level at which supply equalled demand. It built a monetary stockpile.

And now that palladium has been demonetized, there is no need for any such stockpile. Which means that it needs to be worked off. Which means the palladium price will actually fall below its original industrial-commodity level. Ouch! Taste the pain, palladium lovers.

Monetary competition is definitely not for sissies. At least in terms of the abstract economics - we'll get to the reality in a little bit - there is no stable inhomogeneous strategy. All the Nash equilibria are Highlander outcomes: there can be only one. But which one? Ah, that's the fun.

Case B, in which rhodium has already won, confirms our suspicions. Essentially, once there is one monetary standard, there is no need for another.

Once Nitropia is on rhodium, anyone who buys palladium is no different from anyone who is trying to manipulate any commodities market. In a free market, if you want to buy up a bunch of palladium - or wheat or oil or FCOJ - and by so doing raise the price, you may do so. But if you want to actually realize your profits, you have to sell at some point, and there is no reason to think you'll have any luck getting out at a higher price than you got in at. This is called the "burying the corpse" problem, and a thing of beauty it is.

In other words, money is the bubble that doesn't pop. Once rhodium feels the Quickening, any other potential monetary standard is at an incurable disadvantage, because its adherents are mere manipulators. Sooner or later they will get tired and let their guard down, and rhodium will take their heads. But rhodium itself cannot pop - there can be only one, but there has to be at least one. And that's money.

I am not an expert on monetary history, but my general impression is that, while until the late 19th century both gold and silver were monetary metals, places and times in which both gold and silver circulated amicably were rare. For example, China and India were generally silver areas, whereas patches of Europe fluctuated between silver and gold. Since Gresham's law will drive one of the two out if a ratio is fixed, since distributing floating exchange-rate quotes to every cash register was not exactly a practical technology, and since the noncirculating "good money" was generally exported to a region where it was a current medium of exchange, it was hard to avoid any other result.

In the Victorian era, however, the financial system became global, and gold crushed silver much as described above, leading to a worldwide (if very imperfect) gold standard. Silver holders got the shaft. Ouch. (In retrospect, if the US had gone to free coinage of silver, instead of walking the yellow brick road to the cross of gold, we might not have some of the troubles we have today.)

But wait - we have imported an implicit assumption. Why does Sven have to pick a "precious metal?" What makes gold, silver, platinum, palladium and rhodium "precious?" And why does his medium of intertemporal exchange have to be a metal at all?

Well, obviously, it doesn't. Most of us store most of our assets in artificial currencies, or assets producing flows of same (stocks, bonds, subprime AAA CDOs, etc). Clearly, defining Sven's problem as the choice of one of the five major precious metals makes it far too easy. Nor have we described the factors that govern competition between the metals.

We know that I has to be storable. Salmon are out. Definitely out. So let's start from there. Suppose our herd of Svens chooses some other common industrial product which is storable - let's say, axes. How will axes do against rhodium? Can Nitropia somehow get onto the axe standard, and if so will it last?

In fact, axes cannot be used stably as money. The problem is that an axe, as an industrial product, cannot be stably priced above the cost of making an axe.

Probably, as our herd of Svens swarms into the axe market, there will be some hysteresis as the existing axe makers struggle to catch up with the new demand. But catch up they will. After the shock is absorbed, axes will experience no appreciation whatsoever. Moreover, when the Svens flood out of axes into some good that actually can sustain monetary appreciation, such as rhodium, the affair will go down in history as a horrifying "axe bubble." As with palladium, but much worse. The landscape will be littered with rusted-out axe factories, and people will be using axes as doorstops, tire irons, etc, etc.

What is the difference between mining rhodium and making an axe? The difference is that you can make as many axes as you want, and it is still just as easy to make more.

Rhodium, or any precious metal, can sustain monetary appreciation because its supply is restricted by diminishing returns. Appreciation causes the stockpile to increase. But as the stockpile increases, the easily mined deposits are mined out. There is no reason to think that the price will ever go high enough to preclude all new production, but there is no reason to think it can't, either.

Imagine if today's gold price increased by a factor of 10. Would it increase gold production? It certainly would. Perhaps the gold dilution rate might even get up to 5%, meaning 7500 tons produced per year, although if you know the gold industry this is hard to imagine. Higher prices would also stimulate new gold discovery, and gold underground is future gold. It is priced into the gold market through the stocks of companies that own mining rights, and this certainly must affect any dilution rate. Still, however, gold at $10K/oz or even $100K/oz would not come even close to looking like an axe bubble.

In fact, I doubt that either of these astronomical prices could get gold to the present dilution rate of the dollar. As I discussed here, there is no precise way to measure the number of dollars in the world, but perhaps 15% a year is a good rough estimate of the dilution rate. This number is very, very, very high for a currency. Imagine if 20,000 tons of gold could be mined every year. It would basically have to involve some kind of alien earth-moving technology. And how many years could you sustain it for?

Our first-order criterion for Sven is: do what everyone else is doing. Dilution rates are our best second-order criterion for figuring out what everyone else is going to do.

When predicting future exchange rates between rhodium and palladium, with the ceteris paribus assumption that industrial criteria will not affect the price ratio, our first-order concern is the quantity of savings that will flow into each metal. Since monetary demanders are not interested in the good itself - they purchase by value, not by weight, volume, etc - we can think of their bars of rhodium as shares in Rhodium, Inc.

In other words, what they have bought is a fraction of the global rhodium stockpile. New mining increases that stockpile. It obviously does not increase the size of your bars. Thus, if we discount industrial demand entirely, dilution is equivalent to evaporation. If the rhodium stockpile grows by 10%, ceteris paribus, it's as if 10% of your rhodium evaporated into thin air. Or as if storage expenses consumed 10% of its weight.

These second-order factors, like positive investment returns, help drive the herd's choice of currency. Is a 10% dilution rate sufficient to convince a herd to abandon an existing, successful currency? What about 15%? I don't know. Ask Dr. Bernanke. If there is any numerical procedure for predicting monetary herd behavior, I'm certainly unaware of it.

However, factors such as dilution rate need to be evaluated not just in the present, but all along the path that leads to currency fixation. For example, if it really would be practical to extract gold from seawater at $10K an ounce (which it wouldn't), gold would not be a viable global currency. If the entire global financial system migrated into gold, prices would certainly exceed $10K/oz. Therefore, gold would have no possibility of winning the currency competition. It would have no endgame, and anyone holding it now should probably sell.

On the other hand, gold's enormous stockpile makes it far more viable as a global currency than any other precious metal. Stockpiles of the platinum-group metals (platinum, palladium, rhodium, and the minor metals osmium, iridium and ruthenium) are much lower, as are silver inventories. This implies a much more dramatic price response to an influx of savings - but it also implies a much higher dilution rate produced by the influx. I doubt any mineable metal can exhibit any predictable response to a price increase of four or five orders of magnitude. Thus the PGMs, and probably silver as well, do not have a clear path to currency domination. Not that gold's path is in any way, shape, or form clear! But it is much clearer than anything platinum has to offer. And since there can be only one, clarity counts.

At this point we have reached a level of abstract precious-metals theorizing that is certainly well beyond anything any market is likely to assimilate any time soon. Herd strategies only work if the herd actually understands and applies them. Especially considering Wall Street's almost tribal antipathy to gold and goldbugs - perhaps Shayne McGuire is the harbinger of a trend, but if so he is very, very early - we are simply getting ahead of ourselves.

Despite the Highlander logic, I own both gold and silver, and if I had a convenient way to buy it I'd pick up some platinum as well. At present, Wall Street is experiencing a generalized surge of savings into commodities. As investors become more educated on the subject, this may sharpen into a generalized precious-metals surge. By the time you see any kind of game-theoretic decoupling between metals, it will be quite late in the game. Also, gold has a significant disadvantage, which McGuire mentions in his interview: it is the only metal which governments have substantial stocks of. More on this in a minute.

It's time to consider the metals' great competitors, the national or "fiat" currencies. ("Fiat" is in fact the correct technical word, but as a result of repetition by Ron Paul and the like it is starting to acquire pejorative connotations. Unfortunately, this will rub off on the complainers rather than the currencies. Power hath its privileges. "National" and "artificial" are both good words without any strong connotations. You can also just say "paper," which is no more than the truth. And if you like to wax nostalgic for the old Constitution, this essay by George Bancroft may put some fire in your belly.)

Now that we understand what money is, it's easy to see what the national currencies are. They are artificial precious-metal substitutes. Governments always dreamed of alchemy, and now they have it. Like so many youthful fantasies, the reality is not as once imagined, but it is reality nonetheless, and we have to live with it.

Probably the most interesting fact about paper money, and certainly the least understood, is the gradual nature of the transition from metal to paper. Not since the 18th century, in the heyday of the Amsterdamsche Wisselbank, has there been any major financial system on an undiluted metal currency. The so-called "classical gold standard" of the 19C, really the Bank of England standard, was at all times heavily stretched with paper, like bread in a meatloaf. The reason we no longer have anything called a "gold standard" is that, by 1971 when Nixon closed the "gold window," the connection had become so attenuated as to be absurd. It was less a meatloaf than a sort of meat-flavored Wonderbread.

How do you stretch a gold standard? Easily. Print pieces of paper that say "one (1) gram of gold." Compel your subjects to treat them as equivalent to gold. This is the original meaning of legal tender, a concept which is quite confusing without the historical background. If you like, you can back these notes with something, typically debts due in the future, perhaps with a small amount of actual gold to permit "redemption." Or you can just accept them in payment of taxes. The combination of term transformation and legal tender power effectively allows an infinite amount of virtual gold to import itself from the future, via a Rube Goldberg machine so complex that not one out of twenty of your subjects has any hope of understanding it.

Pure paper, without any fond memories of the barbaric relic, is a considerable improvement on the old Bagehotian trickery. It is actually the first step back toward gold. It is very hard to turn a meatloaf back into a steak. It is much easier to restore a true gold standard, with no musical chairs, financial time travel or other wacky hanky-panky, simply by migrating away from paper to gold. Throughout history, paper money has been a cyclical phenomenon, and simple irredeemable paper is the unskippable last step in the cycle.

As Wikipedia puts it:
The history of money consists of three phases: commodity money, in which actual valuable objects are bartered; then representative money, in which paper notes (often called 'certificates') are used to represent real commodities stored elsewhere; and finally fiat money, in which paper notes are backed only by the traders' "full faith and credit" in the government, in particular by its acceptability for payments of debts to the government (usually taxes).
This is Whig history in one sentence. In real history, phase three wraps back around.

Clearly, the fact that paper money has no intrinsic utility is no barrier to its success or stability. In any model of spontaneous currency standardization, whether Law's or Menger's, there must be some original demand for the currency. But any government worthy of the name can create demand where there is no utility. Simply order your subjects to pay their taxes in your national currency. If they don't, arrest them.

I think it's very clear that if there was a fixed stockpile of dollars in the world, as I proposed in this post, the unbacked paper dollar would outcompete all other currencies, natural or artificial, in very short order. Even holders of euros and yen would move their savings into the dollar. These currencies would depreciate rapidly and collapse. So would gold, which would become an industrial metal, and quite a cheap one thanks to its enormous stockpile.

In theory, the dollar is certainly capable of reversing its present losing trend against gold. In fact it pulled off just this trick in 1980, under the leadership of the brilliant Paul Volcker. Mr. Volcker is still with us, and if you start hearing noises about bringing him back, worry. Gold prices declined almost continuously for two decades after his victory.

But don't worry too much, because the Fed does not have the weapons it had in 1980. The main one being 20% interest rates, which went quite a ways toward both ending the monetary dilution of the '70s, and compensating dollar holders for what was left of it. Unbelievable as it may sound, the US economy today is a shadow of what it was in the '70s. As we saw in this latest cycle, it is so debt-laden that it cannot stand 5% rates, even though these are at least -5% when you adjust for dilution. 20% was bad enough in the early '80s. Today, you'd see feral children gnawing each others' bones in the streets.

In theory, if a government cannot control a coordination game (such as currency selection), it is not much of a government. Indeed, when you buy gold, this is precisely the proposition in which you are investing. The Western governments of 2008 are red-giant states: they are as large as they have ever been, but also as weak as they have ever been.

Why is the dollar weak? Why, when the US is running epic trade deficits, are interest rates going down rather than up? Why is the suggestion of a note supply limited by statute, a policy once followed quite effectively by this very same government, an impractical curiosity which does not represent any real threat to gold holders? Why, for that matter, in a time of currency crisis, are Americans allowed to hold gold and silver at all - especially through incredibly convenient instruments such as the precious-metals ETFs, GLD and SLV, which anyone with a portfolio account can use to switch their savings into fully-backed bullion? Why is a senior fellow at what Murray Rothbard used to call the "Rockefeller World Empire" appearing on NPR and touting digital gold currencies?

This, I feel, is the most important question for anyone considering buying gold. Why moon the bull? Why taunt the tiger? FDR faced a combined currency and banking run in 1933. He leaped the fence, broke half the financial contracts in the country, and took the metal back. It was illegal for Americans to own monetary metals for the next forty years. A very simple case of attack and counterattack. Normal politics at its finest. Could it happen again? Legally, sure. And yet something feels different.

The answer is just that FDR is no longer in charge. In fact, no one is.

No one observing the Western governments today can fail to be struck by a massive sense of sleepwalking. There is no unified consciousness or purpose behind their actions. Each of their decisions is an atom unto itself, made through an almost ritualized process by a large number of very intelligent, talented and ambitious people, whose abilities tend to cancel each other almost perfectly, leaving nothing but a chilling bureaucratic continuity.

The modern regime is unable to take basic defensive actions against an impending currency collapse, because it is unable to take any kind of thoughtful action at all. It is certainly unable to admit that it has made any kind of systematic mistake. Because it decided in the 1970s that gold and silver were industrial commodities, it legalized their holding as a kind of gesture of power. There were those in 1971 who thought the gold price would actually decline when Nixon closed the gold window, because now the demonetization was official.

But in the '70s Washington still had men like Paul Volcker, a financial Aetius, with true gravitas and real personal authority. Volcker's austerity measures were something now unthinkable in Washington - a judgment call. He decided to restrict the quantity of dollars and let rates do what they had to do. They did, and it worked. A kind of last gasp of Carlylean government, a Roman ambush of the Huns, doomed perhaps, but still brilliant.

Professor Bernanke is just that - a professor. He is a specialist in a framework invented to employ specialists. Computer science is full of these research empires, full of sound and fury, signifying nothing. Detaching your little subfield from reality is the easiest thing in the world. Reconnecting is almost impossible. First, you'd have to admit on your grant application that you'd been studying something other than reality. If that's hard in Berkeley, try Washington.

Google News does not show me a single recent mention of the word austerity, at least not used by an American with reference to American politics. Imagine if Barack Obama went around the country talking not of "change," but "austerity." "Yes, we can - tighten our belts." Impossible. He's more likely to invade France. So much for the Washington consensus!

The custodians of the post-1945 financial architecture, such as they are, have one weapon which they may still be able to deploy. This is their gold reserves, officially about 30,000 tons. Central banks hold gold so that they can exchange it for their artificial currencies, changing the exchange rate in their favor. Ie, so that they can dump it on the market and trash the price. This is simply a generalization of redeemable currency, in which all discretion is transferred to the bank. It is not a conspiracy. It is normal.

However, it is not at all clear that official gold reserve figures are anywhere near accurate. IMF guidelines have long encouraged central banks to report gold that is "loaned" or "deposited" on a single line with actual monetary gold. In other words, what the bank actually owns is not gold, but an obligation from another party to deliver gold. The real gold has almost certainly been sold, and the counterparty (typically a large domestic bank or foreign central bank) is - at least in theory - "naked short." And not feeling too good about it, at least not these days. This practice was a great way to make money in the '90s when the gold price was declining, and in fact may have been a major cause of that decline. At this point it is somewhat embarrassing. James Turk recently discovered that USG is in on this game, which doesn't look good at all.

The gold lending situation, for no reason I can discern besides basic accounting honesty (something USG is actually quite good at, as it plays into the natural CYA response) appears to be heading slowly toward a correction. If this actually happens, it will be very interesting to see how much gold is actually left. However, there is also a large market in gold options and other derivatives. A central bank has many weapons.

However, we keep running into the same problem: the red-giant state. If you assume that USG and its allies are ruthless and Machiavellian, they have many ways to defend their currencies. But if USG and its allies were ruthless and Machiavellian, they would not have a problem in the first place.

Take the recently proposed IMF gold sales. The gold to be (possibly) sold will not simply be dumped on the market with an auction, a la Gordon Brown. No, it will be shoehorned into the existing Central Bank Gold Agreement, under which European central banks sell 500 tons a year. Nominally, this is a restriction to avoid massive sales that would depress the gold price. Perhaps this was even the original point. At present, however, it appears to be an obligation to prevent the price from reaching escape velocity, an obligation onerous enough that the Europeans would not mind shuffling some of it off on the IMF.

And of course, no one even begins to admit that managing the gold price is the point. Perhaps they are even sincere about this. Why shouldn't they be? Why shouldn't the policies that once were ruthless and Machiavellian have become, after decades of the system believing its own PR, mere force of habit? If the central banks were really managing the gold price, don't you think they'd be doing a better job of it?

As I recently suggested on this RGE thread, there's a simple way to understand the gold market. Think of gold as an artificial currency. Imagine that it's the currency of a small European country, which we can call Goldenstein.

Every year for the last five years, the Goldenstein auro has appreciated by about 20% against the dollar. And that was before the crisis. If we annualize 2008 so far, it's more like a million trillion percent. I exaggerate. Slightly.

This means, of course, that the dollar has lost 20% a year against the auro. Now imagine that you are doing customer outreach for some Wall Street firm that is trying to appeal to Goldensteiners. Specifically, you are trying to persuade them to invest in dollars. Or stocks, or bonds, or any financial asset which produces revenue in dollars. How would you pitch that?

Now imagine that you're a bank in Goldenstein, and you're trying to persuade foreigners to invest in your small but happy country. How would you advertise this service? Would you even have to? Where would it stop? Why would it stop? How would it stop?

Of course, there is no Goldenstein. That is, there is no sovereign country whose goal it is to defend and promote the gold standard. There is no auro, just gold itself. The economics are all the same - but there is no army, navy or air force. Goldenstein may be small, but at least it has a police force with a couple of Glocks and some old bulletproof vests. Gold has nothing at all.

And yet gold, as we've seen, is an existential threat to the greatest military power in the history of the world, one whose legal and financial arms reach everywhere. No corporation can even think about making USG its enemy. What can it do about gold? Anything, if it wants. What should it be doing? Something, definitely. What is it doing? Pretty much squat, as far as I can tell. Perhaps the god has abandoned Antony.

Thursday, February 21, 2008 95 Comments

Democracy as a historical phenomenon

Elections are weird. Then again, so is American football. If we imagine defending either to Hans-Adam II, perhaps we have a start on how hard it is to see democracy as part of history.

To explain anything as part of history is to explain it as foreign. When modern historians talk about the Bourbons or the Hapsburgs, they can be pretty sure there are no Bourbons, Hapsburgs, or rabid partisans of either in the room. No one is about to hound them out of a job for omitting Louis XIV's style as the Most Christian King, or any other act of lèse-majesté. (Perhaps Professor Hindley's offence could be seen as a sort of lèse-democratie.)

It is easy to explain monarchy as a historical phenomenon, because we all know that monarchy is weird. And so, of course, it is. Although not perhaps as weird as we were raised to think. (The Ruler of Sharjah has just displayed His Highness's boundless wisdom in appointing a distant relative of mine to a distinguished academic position, so I'm feeling pretty good about hereditary government at the moment.)

Our great obstacle in thinking critically about democracy is the fact that everything we know about politics and government reassures us that democracy is, while certainly not perfect, the best possible system of government. As I suggested the other week, questioning this tradition on its own terms is about as likely to work as disproving God via Biblical scholarship.

Specifically: demotism is inseparable from the Whig theory of history, in which history is the story of political forms evolving, Great Chain of Being style, toward our present perfection. If democracy is bunk, so is Whig history. But if Whig history is bunk, what isn't? Is there a Tory theory of history, and if so should we subscribe to it instead?

If you grew up in a democracy, as I assume everyone reading this did, there is a little golfball of neural tissue somewhere above your foramen magnum, which contains everything you know about politics and government. If you believe in the Virgin Mary, there is a similar golfball which contains all you know about the Immaculate Conception. If the Virgin has let you down and you are considering believing in Baal instead, you should probably grow a whole new golfball which is dedicated to Baal. Perhaps there is some way to construct a gradual transition from Mariolatry to Baal-worship. But I can't imagine why there should be.

Similarly, if there is any way to stop believing in democracy, the only way to do it is to (a) grow a new golfball that believes in whatever you'd believe in, if you didn't believe in democracy; (b) compare the old and new golfballs, and decide which you're more comfortable with; and (c) allow the loser to be reabsorbed by the rest of your brain, which hopefully is young and flexible enough for this kind of appalling hot-swap auto-neurosurgery.

A good example is the political dimension of "left" and "right" which we're all familiar with. As perhaps you know, this is originally derived from seating patterns in the 1791 Constituent Assembly. A certain Jonah Goldberg has just released a new book in which he argues that "fascism," which most of us probably think of as "right-wing," is in fact better understood as a form of leftism. I haven't read Liberal Fascism, but from the reviews I get the impression that it recapitulates much of the thought of Erik von Kuehnelt-Leddihn. Goldberg may or may not be worth your time, but K-L certainly is.

But is he right? Is "fascism" "right-wing" or "left-wing"? And which would make it worse? Is it better to be "left," or "right," or somewhere in the middle? What about the libertarian Nolan chart, which asserts the existence of a second dimension - and blithely assumes the first? (If to be "left-wing" is to support "personal freedom," what about, say, smoking? Or being rude to someone with the wrong skin color? Or driving too fast?)

It is all a bit of a muddle. Demonstrating, again, why introducing Baal into our Virgin Mary golfball is a waste of time. To question democracy is to admit the possibility that the entire system by which you think about politics and government, past and present, is nonsense. Or at least has no consistent relationship to reality. Perhaps we can understand what "left" and "right" mean from an ademotist perspective, but we need the perspective first.

So: if you knew nothing about government, how would you start to understand it?

The obvious first question is: government of what? Who is this government for? Can one system of government really fit all possible populations? What about aliens? Dolphins? Chimps and ourang-outangs? You have to be able to draw a line somewhere.

I don't find the problem of governing aliens or dolphins interesting or useful at all. All I am interested in is the two-legged things that are walking around on Planet Three at present. There is a common English word for this animal, but I refuse to say it - the word has been attached to many ethical and historical concepts, all of which it imports instantly, without going through any kind of mental security screening. A good way to pick up something that could be hard to get rid of, if you get my drift.

The Latin root cannot be avoided, though, so let's call them hominids. A hominid is any apelike critter that was wandering around on its hind legs any time in the last 100,000 years. No gibbons need apply. Perhaps this is not quite exactly how paleontologists use the word at present, but it is well-known and I will stick with it. If we design systems of government for arbitrary populations of hominids by this definition - quite genetically broad, considering the speed of recent evolution in the species - we are erring on the safe side.

From an engineering perspective, it can't hurt if our theories also work for groups of hominids who are now extinct, and who do not resemble hominids now living. Shifting the bar backward dodges the nasty problem of evaluating the actual populations now living - which a lot of writers seem to get quite hung up on. If we need to make the distinction, we can talk about the protohominids of 100Kya, and the neohominids of 2008. As long as you have some neohominids to actually staff your operation, I'd like to think it is perfectly possible to govern either, both, or any mix of the two.

In any case, history starts with prehistory and prehistory starts with biology. We know three things about hominids: they are social, territorial, and violent. An excellent introduction to hominids in their cladistic context is primatologist Richard Wrangham's Demonic Males. An excellent survey of prehistoric territorial behavior among hominids is anthropologist Lawrence Keeley's War Before Civilization. Hopefully these readings will be sufficient to rid you of any lingering Rousseauvian golfball that may be clogging up your foramen magnum.

Briefly, hominids exhibit what might be called a default pattern of government. In the default pattern, the basic unit of government is the tribe, which controls a well-defined territory and defends it from other tribes. The tribe has a chief, generally male, whose decisions are final. He maintains power by using it to reward his friends, relations, henchmen, lackeys, etc.

Hominids are very flexible and intelligent animals. They can exist in a wide variety of cultural configurations, with all kinds of weird power dynamics. The default pattern (which we see even in chimpanzees) is not inevitable.

But it gives us a concise definition of government. A government is either (a) the default pattern, or (b) whatever organization militarily suppresses the default pattern.

Can hominids exist without government in this sense? No, because hominids are social and violent. You might be able to breed a two-legged animal that was asocial or nonviolent, but why call it a hominid?

A more interesting question is whether a system of nonterritorial "protection agencies," as proposed by anarcho-capitalists like Murray Rothbard and David Friedman, can exist. The correct question is: could such a system stably suppress the default pattern? In the absence of a superior force which constrains its actions, the only distinction between a "protection agency" and a "government" appears to be that the former exhibit territorial overlap. Especially given hominid territorial instincts, can any such system be militarily stable? I doubt it, but I am not a military expert. Of course, neither are most anarcho-capitalists.

Occam's razor suggests to me that schools of political thought which purport to be "anarchist," a category which includes both anarcho-capitalism and Marxist-Leninism (both Marx and Lenin constantly insisted that they were not replacing the hated state, but building a new kind of social system which would express the will of the people directly) exist and even flourish not because they have a realistic strategy for eliminating government without returning to the default pattern, but because they capitalize on the natural antigovernment frustrations of hominids who find themselves with neither political power nor any prospect of attaining it.

I am all for a polycentric world. I personally would be very happy to see a planet with thousands, even tens of thousands, of independent polities. However, sovereign actors have enough trouble relating to each other even with nonoverlapping jurisdictions. If the advantage of overlapping is, as it appears, that it lets you call your governments "protection agencies," I have to question the sincerity of the proposal.

Libertarians - even anti-democratic libertarians, like Hans-Hermann Hoppe - owe more to Locke than I think they realize. Locke was a Whig and a Puritan, and a great tabula rasa man. The god of battles has treated his faction kindly. I don't believe this is a coincidence, but I don't think it makes Locke right. I'm sure he was a very nice guy, but Locke knew no more of hominid behavior than a cat knows of tennis. And I think any remaining Lockeans could stand a good strong dose of his Tory debunker, the sadly under-appreciated Josiah Tucker.

For the benefit of 21st-century readers, here is a tasty bite of Tucker in modern orthography (the OLL edition also contains many OCR errors; if you can stand the long S, try the original). Here, Tucker is comparing the divine right of kings to the divine right of the People:
Once more: all laws made, or to be made by the authority of usurpers, alias of Kings de facto, are, according to the doctrine of Sir Robert Filmer and the Jacobites, absolutely null and void; ’till they shall have received the sanction and confirmation of the rightful King. And so say the Lockeans in respect to their sole rightful King, - the People. For here again they have told us so often, that we cannot forget it, that no law can be valid, unless the People have authorized the making of it. Nay, they have gone so far as to declare, that the very essence of slavery doth consist in being governed by laws, to which the governed have not previously consented.

This being the case, you see plainly, that the consideration, whether the law be good or bad in itself; whether it is a law that is wanted or not wanted; and whether it tends to promote the liberty of the subject, or to restrain it, is at present entirely beside the question. For the sole point here to be determined, is simply this. Had the makers of such a law any right to make it, according to the Lockean ideas of right and wrong? If they had no such right, they must be pronounced to be usurpers, be the law in itself whatever it may; and therefore as they are usurpers, their doom is fixed; inasmuch as they cannot expect mercy for their daring attempts to alienate the unalienable Rights of Mankind.

Before this Lockean system had been broached, or at least before it had made many proselytes among us, it used to be considered as no bad maxim in politics, “not to be very inquisitive concerning the original title of the reigning powers.” For if the State was actually at peace, and if every man sat, or might sit under his own vine, and his own fig tree; or in plainer English, if the essential ends of government were answered both by the protection of good subjects, and by the punishment of bad ones, and also by the defence of the community from external violence; - then it was thought, that this was a sufficient reason for considering such powers as ordained of God. And if ordained of God, the people ought to obey them, under peril of damnation.

But now it seems, the world is grown much wiser. For the first question to be asked is, what is your title, to be the governor, or chief magistrate of this country? And what proofs do you bring that you have received your authority from the People, without fraud on the one hand, or violence on the other? Answer me this, before you can expect, that I should submit to obey you.

Few governors, I believe, would like to be catechized after this manner by their subjects. And fewer still would be able to answer these questions to the satisfaction of a Lockean patriot. Nay, we have been expressly told by one of the chief among them, Dr. Priestley, that there is not a government on the face of the globe, which can stand the test of such an enquiry. “For, says he, all governments whatever have been, in some measure, compulsory, tyrannical, and oppressive in their origin.”

Now this being the case, why will not these benevolent, political philosophers, erect a government of their own, for the good of mankind; - a government on their own plan, and perfectly agreeable to the Lockean principles; which shall therefore be a pattern for the rest of the world to copy after? Nay, why are they always sowing discords and dissentions among us, instead of establishing a free, and equal, and harmonious republic among themselves? Most certainly Great Britain is not the proper spot for exhibiting specimens of this sort. Because, to say the truth, we have had, and we have felt, too many of these political experiments already, during the last century, to wish to have them revived again.

But America! Yes, the interior parts of America is the country of all others, the fittest for putting every fond imagination of their hearts in practice. For if fame says true, and if Mr. Locke himself is to be credited, there is as yet no government at all in the inland parts of those immense regions. Nor have even the Congress extended their gentle sway beyond the lakes Erie and Ontario, if they have gone so far.

Thither, therefore, let all our republican patriots speedily repair. Time is precious, and the cause invites. A passport will undoubtedly be granted them, as soon as applied for. And ample leave will be obtained to exchange the slavery of this country for the freedom of America. Thither, therefore, let them all retire. For there they will live (according to the prediction of Dr. Price) undisturbed by bishops, nobles, or kings; and there likewise they will enjoy all the blessings which can attend that happy state, where every member of society will be his own law-giver, his own governor, judge, and director.
As Steely Dan put it, "all I can say is ouch."

I'm afraid we have, indeed, had "too many of these political experiments." You know what I want? The sinister, futuristic totalitarian fantasy at the heart of Mencius Moldbug Thought? I want to live in a world where when I go to Google News and search for poisoned arrows, I get no hits at all. I mean, call me crazy.

In any case, we have observed a problem with the word government. People have strange associations with it. As we've seen, it is not hard to define, but perhaps it is worth replacing.

I will stick with the word sovereign, which is old but whose definition is beautifully precise, and the extremely bland term organization, which just means a group of hominids working together in some coherent way. (In the past I tried corporation, which means exactly the same thing, but has undesirable pejorative connotations.) Thus instead of "government" we can say "sovereign organization", or sovorg.

Since sovorgs are territorial by definition, we can name them by location. Thus, for example, there is a very important sovorg on the Potomac. We can call it Washorg. Furthermore, while heeding Dean Tucker's wise warning against inquiring too closely into "original title," we can distinguish four discrete revisions of Washorg, separated by breaches of legal continuity - in 1789 (Confederation to Constitution), 1861 (state to national sovereignty), and 1933 (limited to unlimited government). So our present lovely confection is Washorg-4.

Is Washorg-4 good or bad? The question is absurdly underconstrained. Good or bad to whom, and for whom? What makes a sovorg good or bad? What makes anything good or bad? These are normative questions. Presumably, for Kim Jong Il and his family, North Korea is not bad at all.

Though clearly, to anyone on either side of the Atlantic in the 1770s, Washorg-4 would seem an appalling monstrosity. The Dean himself is quite incisive on the point:
Here therefore be it observed, that without taking any advantage from the arguments that may be deduced from the tarring and feathering of their numerous mobs; and without insisting on the burning and plundering of the houses, and destroying the property of the Loyalists by the American republicans, even before they had openly thrown off the mask, and set up for independence; - I say, without bringing these instances as proofs that they would not grant that liberty to others, for which they so strenuously contended for themselves; - let us come to that very period, when they had established various civil governments in their respective provinces, and had new-modelled their several constitutions according to their own good liking: - I ask therefore, was any one of these civil governments at first formed, or is it now administered, and conducted according to the Lockean plan? And did, or doth any of their Congresses, general or provincial, admit of that fundamental maxim of Mr. Locke, that every man has an unalienable right to obey no other laws, but those of his own making? No; no; - so far from it, that there are dreadful fines and confiscations, imprisonments, and even death made use of, as the only effectual means for obtaining that unanimity of sentiment so much boasted of by these new-fangled republicans, and so little practiced. In one word, let the impartial world be the judge, whether the Americans, in all their contests for liberty, have even once made use of Mr. Locke’s system for any other purpose, but that of pulling down, and destroying; and whether, when they came to erect a new edifice of their own on the ruins of the former, - they have not abandoned Messrs. Locke, Molyneux, Priestley, and Price, with all their visionary schemes of universal freedom, and liberty of choice.
(I particularly admire the Dean's deft hand with semicolon and dash; - a move he shares with Frank Bidart. If you find this paragraph hard to parse, his argument is that any difference between the new American and the old British regime is essentially cosmetic; - a point now admitted by all.)

In any case, the question remains: good or bad?

I will take the liberty of assuming that readers share my general taste in government. I suspect that taste in this matter is much like taste in restaurants. People can argue KFC versus Popeye's or Mickey D versus BK, but no one puts any of them in a class with Nobu or the French Laundry. If you can't agree that Vaduz is well-governed and Pyongyang is not, you are just quarreling.

A simple way to ask the question is: if all things were equal, where would I rather live? If SF was owned and operated by Hans-Adam II, and Berkeley was owned and operated by the Kims, would I prefer to make my home in the East Bay, or the West?

We can distinguish two factors in this decision: customer service, and personal authority. Customer service expresses the way the sovorg treats me, its customer or resident. Personal authority expresses any power I may have over the operations of the sovorg.

Suppose it is not Kim, but I myself, who run Berkeley. If I was the Ruler of Berkeley, it would undoubtedly serve me quite well. "I'm not just the Ruler - I'm also a customer." Would I settle for the ordinary, plain-Jane service? Heck, no. I would have a limo, and uniformed flunkies. But it would still be customer service - just extraordinary customer service.

This, however, would not express all the satisfaction I received from ruling Berkeley. After all, I too am a hominid. And hominids like power. While I am not as far as I'm aware descended from Genghis Khan, I'm sure that possession of political power has often lubricated my Y chromosome's path to survival. This sort of thing leaves an impact.

Suppose I was not sole Ruler of Berkeley, but just one member of a Triumvirate. The service would probably still be excellent. The limo might not be as swank. And my will could be frustrated by any two of my co-triumvirs. Definitely a step down. On the other hand, to make anything in Berkeley happen, all I have to do is persuade two people. How hard can that be?

Suppose instead I was one member of a Grand Council of 100, whose by-laws strictly barred any special treatment. Berkeley would treat me, and my fellow Grand Councilors, just as it treated any other resident. But as long as I could browbeat fifty of my peers into submission, my will could still hold sway.

What we see here is that personal authority, an intangible good but still a very desirable one, can be disconnected from customer service. We see also that since personal authority is directly desirable, it need not follow any mathematical principles, linear or otherwise. Is being sole Ruler of Berkeley three times as cool as being a Triumvir? Maybe, but maybe not. Is being a Triumvir 33 times as cool as being a Grand Councilor? Probably not.

Of course, if Berkeley is a democracy with universal suffrage, any Berkeleyite who is full-grown and capable of breathing is, effectively, a minor dignitary. There is no limo and no flunkies, but there is still a small but intangible sense of somehow controlling events. Voting in a democracy makes you feel powerful, much as playing the lottery makes you feel rich. Perhaps it shouldn't. But why not? Perhaps you will win the lottery, and your vote will matter.

Absolute power corrupts absolutely. Negligible power certainly does not corrupt absolutely, but I'm not sure it corrupts negligibly, either. By handing a tiny slice of power to each of its residents, democracy performs the most essential task of a political structure: rewarding its supporters. If you can convince yourself to see this transaction as sordid and onanistic, you have taken a big step toward ademotism. Until voters learn to renounce this little wafer of fictitious authority that it regularly drops on their tongue, they will never free themselves from democracy.

Once we factor out personal authority, we are left with customer service. As the contrast between Vaduz and Pyongyang demonstrates, sovereign customer service can include almost anything in life. A nasty sovorg can enslave you, murder you, force you to wear nothing but shapeless, scratchy gray overalls, etc, etc. By definition, you have no recourse.

What does good sovereign customer service mean to me? High security, low taxes, attractive landscaping, and an absence of pointless restrictions on my personal actions? Again, defining good government is not unlike defining good food. Reasonable people will tend to agree.

It is a very striking fact, therefore, that sovereign customer service in the world today - and specifically, the customer service provided by Washorg-4 - seems to be so poor. Imagine if Hans-Adam II were in charge not of Berkeley, but of California. Don't you think he could make it such a desirable place to live that it would empty out the rest of North America? It's not like California doesn't have room for 300 million people. Of course, it's not clear that Hans-Adam would want them all. I certainly wouldn't.

Before we look at how Washorg-4 got to its present parlous state, there's a very important aspect of sovereign customer service that is easy to miss. It provides a clue to the rest.

The question is how the sovorg controls its residents. We know that for it to be sovereign, it must do so. Otherwise, the default pattern will reemerge. Internal control is a strictly negative aspect of customer service - except for the fact that almost any sovereign form is preferable to the default pattern (since I am not well suited to tribal gang warfare), it can do nothing but annoy and inconvenience me and other residents.

There are two basic classes of internal control. A sovereign can control its residents by managing their minds, or managing their bodies. We can call the former mode psycharchy, the latter physarchy. A psycharchy persuades its residents to refrain from organizing, seizing and capturing it. A physarchy physically restrains its residents from organizing, seizing and capturing it.

From a customer-service perspective, which is more desirable? Psycharchy or physarchy? What's neat about this question is that, if you are like me, you probably don't have a knee-jerk answer. We have made it off the map of our democratic conditioning. No one wants to be physically dominated by an irresistible authority. But no one wants to have their minds controlled, either. And logic offers us no third choice.

Perhaps it helps if we separate physarchic techniques of internal control into two classes, which we can call legarchy and phobarchy.

Under legarchy, the sovorg exercises internal control as an extension of the judicial system which keeps residents secure from each other. It simply adds a class of offenses which are crimes against the sovorg itself, without any other direct victim. For example, you may not train your paramilitary militia in the Sierras. You may not keep a cache of automatic weapons in your basement. If you are in a crowd and the police order you to disperse, you must do so.

Violating any of these restrictions cannot be described as a tort against any person. They are pure infringements on your personal freedom. They may even be arbitrary and inexplicable. However, as long as they are at least predictable, their impact on a reasonable customer is minimal. Every city in the world has the death penalty for stepping in front of a bus. How do we live with this draconian, irrational, and instantly enforced rule? By not violating it. Most of us never give the matter a second thought.

Whereas most of us would howl to high heaven if Washorg-4 published a list of illegal organizations, for which membership incurs criminal penalties. But it is no more irrational to punish a resident for joining an organization than for stepping in front of a bus. If you relish the collegial pleasure of community, find some community that isn't trying to overthrow the government. Otherwise, can you really complain?

We enter a different territory with phobarchy, which is the tactic of maintaining internal control by unpredictable intimidation. "Death squads," for example, are a classic technique. Most of us consider finding bodies on the doorstep, let alone being one of the bodies, remarkably unacceptable from a customer-service perspective. However, since many 20C sovorgs have maintained power by exactly this method, we would be foolish to dismiss it.

Phobarchy - terrorism, essentially, in the original sense of the word - is best seen as a sort of force multiplier for weak or insecure sovorgs. Of course, it can also be used by organizations which do not hold power, but are contending for it. If you are secure in power, you have no need to strike fear into your enemies by spectacular random attacks. You know who they are. You can have them arrested, and imprisoned or deported according to taste. Moreover, if you are genuinely secure, potential enemies should be able to recognize the fact just as well as anyone, and they will abandon their pointless struggle. Everyone who fights fights to win.

Psycharchy is a method of internal control by which a sovorg manages its residents' opinions, emotions and perceptions. If residents love, cherish and honor their Sovorg, they are far less likely to become unruly. Of course, for this to work, they need to actually be under the impression that their thoughts are their own, or at least are obtained from fundamentally trustworthy sources. This adds a touch of derring-do to the affair.

Drugging the water supply, inserting subliminal messages in fast-food ads, and beaming slogans into your tooth fillings are uncommon, ineffective forms of psycharchy. Mandatory loyalty training for children, official support for approved information producers, and social, civil or criminal penalties for wrongthink are common, effective forms of psycharchy.

The second is especially interesting. I think a special word, massarchy, is appropriate for the 20C system of internal control via education, journalism and science. Each of these words assumes a systematic professional infallibility, entirely unearned in the case of the first two professions, and increasingly dubious in the case of the third. The Third Reich had its own wonderful word for the distribution of official information, Aufklärung - meaning literally, "clearing up," and more broadly enlightenment. Indeed, all the state-sponsored information professions see their task as that of enlightening the public. And from enlightening to guiding is a small step indeed.

What's puzzling about psycharchy is that psycharchy basically sucks. Yet we see it everywhere. Unraveling this mystery is crucial, I feel, to an understanding of democracy.

Psycharchy is lousy customer service, because it's creepy and weird. I want my sovorg to keep marauding gangs from assaulting my residence. I don't want it to care what I think. I certainly don't want it to take any kind of a fatherly interest in what my children think. Raising kids is hard enough as it is. When they come home from school and start reciting government slogans, the temptation to lock them in the closet may become overwhelming.

But psycharchy is also very unreliable as a mechanism of internal control. If you need to prevent your residents from organizing private paramilitary movements, tell them not to organize private paramilitary movements, warn them if they do, and if they don't desist, arrest them. Not only is this is about twelve million times easier and less intrusive than brainwashing generations of children to swear obedience to the State, it's also a heck of a lot more effective. Children are notoriously fickle. If you tell them to think X, sometimes they decide to think Y instead, just for the pleasure of misbehaving.

Worse, if psycharchy relies on propagating a perception of reality that a sensible, independent person would not share, it is unstable in the nastiest way. The so-called "marketplace of ideas" is a strange market indeed when your friendly local sovorg has a thumb on every scale. But if the thumb ever starts to slip, look out. The truth has strange advantages of its own. A sovorg whose continued rule depends on successful psycharchy is like a city below sea level. It can engineer the world's best seawalls, dikes, and levees, but only one of them has to fail.

So we conclude that, from both sides of the game - the sovorg and its customer - legarchy is the most desirable system of internal control. Except in the nastiest, most unusual situations, amounting more or less to civil war, it is the only approach any sovorg should need. And yet history shows us that almost all 20C sovorgs relied heavily on psycharchy, phobarchy, or of course both. What gives?

What gives is that comparing 20th-century sovorgs is like comparing German restaurants. No doubt some are better than others, but unless you like sausage, cabbage and root vegetables, you are basically out of luck.

Even Washorg-4, certainly among the best of the lot, would have appalled not only Josiah Tucker but also the American rebels he so despised. Most of whom can be found delivering quotes on the subject of "democracy" that make Hitler sound like Barack Obama. Note that most of these soundbites (Federalist 10 being a good example) date to the late 1780s, which means that they were products of experience, not ideology. Even Burke started out as a Whig. What made him change his mind? Not Dean Tucker, that's for sure.

It is striking how few people read Federalist 10 in the light of actual historical experience. Surely it is plain to everyone that the problems Madison describes are real, and the solutions he proposes are quackery par excellence. For example:
The other point of difference is, the greater number of citizens and extent of territory which may be brought within the compass of republican than of democratic government; and it is this circumstance principally which renders factious combinations less to be dreaded in the former than in the latter. The smaller the society, the fewer probably will be the distinct parties and interests composing it; the fewer the distinct parties and interests, the more frequently will a majority be found of the same party; and the smaller the number of individuals composing a majority, and the smaller the compass within which they are placed, the more easily will they concert and execute their plans of oppression. Extend the sphere, and you take in a greater variety of parties and interests; you make it less probable that a majority of the whole will have a common motive to invade the rights of other citizens; or if such a common motive exists, it will be more difficult for all who feel it to discover their own strength, and to act in unison with each other. Besides other impediments, it may be remarked that, where there is a consciousness of unjust or dishonorable purposes, communication is always checked by distrust in proportion to the number whose concurrence is necessary.
The influence of factious leaders may kindle a flame within their particular States, but will be unable to spread a general conflagration through the other States. A religious sect may degenerate into a political faction in a part of the Confederacy; but the variety of sects dispersed over the entire face of it must secure the national councils against any danger from that source. A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project, will be less apt to pervade the whole body of the Union than a particular member of it; in the same proportion as such a malady is more likely to taint a particular county or district, than an entire State.
This reminds me of nothing so much as the bit in Isaac Asimov's Foundation where the Mule appears and Hari Seldon starts spewing utter nonsense.

Reading a document like Federalist 10 is like reading an explanation by the chief engineer of the Space Shuttle of how, when the shuttle is built, it will be cheaper to take a vacation in space than in Australia. The fact that the thing was built and is still operating is interesting, but a brief perusal of the design documents tells us that it is not operating in anything like the way envisioned by its designers.

If the exercise of thinking through the problem of government from scratch has convinced me of anything, it has convinced me that effective government and good government are one and the same thing. As long as a sovorg is effectively and coherently managed and its proprietors are motivated by ordinary hominid motivations, such as money and power (preferably the former), it will deliver what we think of as good government, and it will not engage in nasty and dangerous practices such as phobarchy and psycharchy.

So I conclude that if 20C sovorgs have not delivered good customer service, it is simply because they are not and have not been well-managed. Think of them as the equivalent of Pemex, perhaps if Pemex was a tax farm rather than an oil monopoly. Why hasn't Pemex gone out of business? Uh, because it can't?

To see democracy as a historical phenomenon, to understand how this disaster could have happened, we have to interpret it as an internal element of a sovereign organization - not internal in the sense of pertaining to residents rather than foreigners, but in the sense of "internal memo." No one who helped create Washorg could have imagined the present state of Washorg-4, let alone hoped for it. Yet it is what it is now, and most of its residents cherish and revere it. How did this happen? It just did. The thing can't really go out of business, after all.

So when we look at psycharchy as a conscious strategy, it strikes us as silly. Suppose, for example, that the Elders of Zion secretly control the government, which secretly controls the media, which brainwashes Americans into not suspecting that they are actually subjects of the Zionist Occupation Government - the infamous ZOG.

It should reassure us to realize that this makes no sense at all, as indeed it does not. Why should the Zionists bother with secrecy and manipulation? If they really control the government, isn't the Duke of Wellington's motto - pour la canaille, la mitraille - perfectly sufficient? Presumably if the Iron Duke had lived another half-century he would have modified it to pour la canaille, la mitrailleuse, which doesn't rhyme as well but makes even better military sense. (Canaille is rabble, mitraille is grapeshot, mitrailleuse is machine-gun.)

I feel this is a pity, because I for one would be quite reassured to learn that the Elders of Zion were in control. (I'd prefer Hans-Adam II, but given Hans-Adam's success in the financial industry I suspect he and the Elders would work quite well as a team.) Actually, the truth is much uglier than this. The only way I could imagine it being worse is if it involved Cthulhu, which it doesn't - at least not as far as I can tell.

The truth is that no one is in control. In Washorg-4 and its global friends and relations, we are looking at a gigantic, spontaneously evolving, uncontrolled system. The decision-making process we call "democracy" is best seen as part of this system, as are the "voters" whose opinions guide Washorg-4's decisions. Since Washorg-4 is a massarchy, since it guides public opinion as well as being guided by it, it can only be seen as a dynamic feedback loop.

(Anthony Blair, in his last speech before retiring, presented what I think is his own analysis of this situation. While I don't agree with it in all respects, while it certainly understates the magnitude of the problem, I think Blair's media speech may well prove to be the last frank and honest public statement by any democratic politician, ever. For all I know he even wrote it himself. This might be overstating things, but it's certainly well worth a read.)

If our feedback loop is converging on any attractor, our only way to predict it is to study the dynamics of the loop itself. The assertion that any stage in this loop - mass opinion, the official information organs, or Washorg-4 proper - has any tendency to converge on sanity and good sense is unsubstantiated at best. It could even be described as laughable. The system could be fluctuating randomly and unpredictably, or it could be headed for some stable point that almost everyone in 2008 would consider horrifying and unbearable.

This is why I am so keen on finding a way to terminate Washorg-4. It is extremely dangerous and completely out of control. What else do you need to know?

What's particularly nasty about the feedback loop of democratic massarchy is that when we ask why Washorg-4 does what Washorg-4 does, when we look to understand or at least predict it, our only answer is that its future actions are best predicted by whatever perspectives are most strongly selected in the loop.

Unfortunately, this includes a class of perspectives like the one I described last week. No one, or at least hardly anyone, who brought us the ruling underclass, the Brahmin-Dalit alliance and the strategy of yi yi zhi yi thought, or thinks, of these policies as ruthless or Machiavellian. Au contraire - in their logic and their stated objective, they are almost saintly.

Because these policies are conceived as saintly, they are very successful in the stage of the feedback loop that involves replicating perspectives. Everyone wants to be saintly. However, because these policies have a ruthless and Machiavellian effect, they are very successful in the sovereign stage of the loop. At each step, they defeat the competition. If there is any effect that will stop this loop from reinforcing itself monotonically over time, it is not obvious to me. It is very possible that the sooner it can be terminated, the easier the job will be.

I know I am turning into a hopeless Charles Francis Adams groupie, but let's take one last look at that essay I mentioned the other week. What's so neat about "An Undeveloped Function" is that Adams not only explains the past, but provides a horrifying glimpse of the future. Of course, he thinks he is helping, but he is dead wrong.

Take a look at his conclusion:
As I have also, more than once already, observed, this Association is largely made up of those occupying the chairs of instruction in our seminaries of the higher education. From their lecture rooms the discussion of current political issues is of necessity excluded. There it is manifestly out of place. Others here are scholars for whom no place exists on the political platform. Still others are historical investigators and writers, interested only incidentally in political discussion. Finally some are merely public-spirited citizens, on whom the oratory of the stump palls. They crave discussion of another order. They are the men whose faces are seen only at those gatherings which some one eminent for thought or in character is invited to address. To all such, the suggestion I now make cannot but be grateful. It is that, in future, this Association, as such, shall so arrange its meetings that one at least shall be held in the month of July preceding each presidential election. The issues of that election will then have been presented, and the opposing candidates named. It should be understood that the meeting is held for the purpose of discussing those issues from the historical point of view, and in their historical connection. Absolute freedom of debate should be insisted on, and the participation of those best qualified to deal with the particular class of problems under discussion, should be solicited. Such authorities, speaking from so lofty a rostrum to a select audience of appreciative men and women could, I confidently submit, hardly fail to elevate the standard of discussion, bringing the calm lessons of history to bear on the angry wrangles and distorted presentations of those whose chief, if not only, aim is a mere party supremacy.
The basic point of the essay is that politics in the 19th century went mad, and took public opinion with it. Or possibly the other way around. Or both. In any case, in the world of 1901, political hysteria is rampant and unchecked, and the sanity of the 1860s (!) is a distant memory.

And what is his solution? It is the worst idea I could possibly think of. It makes little Jimmy Madison's genius prophecy, that the United States will be too large to have political parties, look like Hari Seldon on his best day.

Adams proposes to introduce historians into politics. That is, he believes that persons such as himself, possessed of tremendous taste, experience and judgment, can raise the level of public opinion by bringing historical perspective to factional political debates. A very common sort of thought for an aristocrat of Adams' Liberal Republican or Mugwump ilk.

While as far as I know this specific proposal was never implemented, it is certainly the case that over the next twenty years the American intellectual class began its great project of capturing public opinion, at the expense of barbaric political chiefs, old-school press lords, capitalist robber barons, and others now routinely depicted as demonic. The project was essentially complete by 1933, when the dilettante figurehead FDR took power at the head of his academic "brains trust" - installed courtesy of Southern racists, urban Irish and Italian machines, and the other corrupt vote banks that comprised the Democratic party. All of whom would get, as Mencken so nicely phrased it, the government they deserved.

The only problem with this triumph is expressed by a little saying I once heard, which is that if you put a drop of wine in a barrel of sewage, you get a barrel of sewage. If you put a drop of sewage in a barrel of wine, you get a barrel of sewage. The saying did not go on to remark that if you put a dam at one end of Napa Valley and a sewer line at the other, you get a whole wine industry devoted to bottling sewage and selling it as Cabernet. But we can infer it.

Adams, who really ought to have known better, thought it would be possible to improve the American political system by connecting it to the American intellectual system. Perhaps he thought he had some kind of one-way valve (that "select audience of appreciative men and women," perhaps?) that he could install between the two. The result was inevitable, abominable, and yet grimly hilarious. Somewhere, Lord Acton is certainly laughing.